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Limited asset market participation and the consumption-real exchange rate anomaly

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  • Robert Kollmann

Abstract

Under efficient consumption risk sharing, as assumed in standard international business cycle models, a country's aggregate consumption rises relative to foreign consumption, when the country's real exchange rate depreciates. Yet empirically, relative consumption and the real exchange rate are essentially uncorrelated. This paper shows that this `consumption-real exchange rate anomaly' can be explained by a simple model in which a subset of households trade in complete financial markets, while the remaining households lead hand-to-mouth (HTM) lives. HTM behaviour also generates greater volatility of the real exchange rate and of net exports, which likewise brings the model closer to the data.

Suggested Citation

  • Robert Kollmann, 2012. "Limited asset market participation and the consumption-real exchange rate anomaly," Canadian Journal of Economics, Canadian Economics Association, vol. 45(2), pages 566-584, May.
  • Handle: RePEc:cje:issued:v:45:y:2012:i:2:p:566-584
    DOI: 10.1111/j.1540-5982.2012.01705.x
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    JEL classification:

    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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